Shorting our Future

An account of the collapse of the American subprime mortgage securities market may sound more like a sleep aid than a New York Times bestseller. Yet American author Michael Lewis has managed to tell the story of the subprime collapse by combining history, finance, and biography into what is surely one of this year’s most entertaining books. Lewis, a former bond trader and Princeton graduate, is well-known for his eminently readable accounts of the booms and busts of Wall Street and financial markets; his inaugural novel Liar’s Poker (1989), another New York Times bestseller, chronicled the rise and fall of legendary investment bank Salomon Brothers and the company’s curious assortment of eccentric and egomaniacal characters. His latest book, The Big Short, is a uniquely accessible and thought-provoking look at systemic problems in American finance. Lewis deftly weaves the unbelievable but true stories of several prescient people who made enormous sums of money by “shorting” (that is, anticipating a drop in value) the subprime mortgage market in 2005-2008, even as the global economy faltered and other investors and banks around the world saw their portfolios evaporate.

The most memorable of the investors chronicled in the book is Steve Eisman, a brusque and highly critical investment manager who “held a picture of the financial world in his head that was radically different from, and less flattering than, the financial world’s self-portrait.” A typical analysis from Eisman was peppered with profanity and decidedly harsh – his reports featured such acerbic gems as, “The Lomas Financial Corporation is a perfectly hedged financial institution: it loses money in every conceivable interest rate environment.” With people skills that consist largely of “a talent for offending people”, Eisman continually struggles to find clients. His fortunes change when Greg Lippmann, a Deutsche Bank trader later recognised as one of the first to fully understand the seriousness of sub-prime mortgage securitisation, approaches him with a proposition—to bet against the subprime mortgage market with abandon. At this point, Eisman had done significant research into subprime mortgages and was already convinced that the market was fundamentally flawed. When Lippman provided him with a way of betting against the market, Eisman saw it as a sure thing.

Another unusual protagonist in The Big Short began to make a name for himself by posting investment insight and stock picks online during the dot-com stock market boom while studying full-time as a neurology resident at Stanford University. Michael Burry’s astoundingly accurate advice drew the attention of several well-known investors, some of whom ultimately invited him to invest millions of dollars on their behalf. He used their money to start a hedge fund called Scion Capital, which went on to earn excellent returns for its investors. Few knew that Burry was completely blind in one eye or that he had Asperger’s syndrome, as his profound social awkwardness meant he preferred to interact with his new clients over the Internet. But his results spoke for themselves. Lewis describes how having Asperger’s worked to Burry’s advantage as he became obsessed with analysing the minutiae of mortgage agreements, a Herculean task that requires high levels of concentration and long hours of solitary confinement (trademarks of many people with Asperger’s).

Burry, Eisman, and the other investment managers profiled by Lewis all saw that the subprime mortgage market was bound to collapse and each found a way of setting themselves up to earn huge amounts of money. The protagonists are repeatedly contrasted with the surprising incompetence of day traders and investment managers at established Wall Street institutions. As their stories unfold, the protagonists discover incompetence (not to mention complacency) at every level—from desk traders all the way up to Ken Lewis, CEO of the Bank of America, and Ben Bernanke, Chairman of the US Federal Reserve. Steve Eisman recounts his thoughts while listening to Ken Lewis speak: “I said to myself, ‘Oh, my God, he’s dumb!’ A lightbulb went off. The guy running one of the biggest banks in the world is dumb!”

The book’s greatest pleasure is in the experience of seeing the financial world through the eyes of the protagonists. Independently, they come to realise that they are not missing something or losing their mind. It emerges that virtually everyone else involved with subprime mortgages, from the much-maligned ratings agencies to the firms like AIG that assumed virtually limitless risk, is frighteningly incompetent, deluded, ignorant, or simply apathetic. The reader can experience the excitement as the characters evolve from curiosity to epiphany to self-doubt to gamble, and ultimately to an unrivalled payoff.

Of course, the picture is not as simple as Lewis might have you believe. It is tempting to gleefully lionise the traders—individuals who held the financial system to account for ruthless and reckless behaviour and managed to profit handsomely for their “admirable” behaviour. Yet an uncomfortable truth remains; namely, that individuals like The Big Short’s heroes were driving demand for so-called synthetic investments. For example, when Eisman unequivocally finds out that he is driving this demand, he tells Lippmann “Whatever that guy [a smug major investment manager named Wing Chau] is buying, I want to short it.” Lippmann took it as a joke, but Eisman was completely serious. “Greg, I want to short his paper. Sight unseen.” Without anyone like these “heroes” shorting the subprime mortgage market with such abandon, it arguably could not have grown to become leveraged far beyond reason, and its implosion might not have had such far-reaching consequences.

Lewis’s first book was intended to be a precautionary tale for undergraduates considering a career in banking, as Lewis later commented that he hoped that all bright young undergraduates would “spurn the job offer from Goldman Sachs” and take up careers elsewhere. His first book did not fully accomplish its intended goal; indeed, the prologue to The Big Short describes how many undergraduates in the 1990s wrote to Lewis to ask if he had additional tips for making it big in finance. And the trends appear to continue unabated. According to Harvard financial historian Niall Ferguson, 20% of the men in Harvard’s 2007 graduating class still expected their jobs to be at banks. Perhaps in light of the recent recession, Lewis’s latest attempt to demonstrate the often rotten underbelly of the overly glamourised world of international finance might just convince a promising student or two to bypass the City or Wall Street for other sectors.

Joel Krupa is reading for an MSc in Environmental Policy Mansfield College, Oxford. Braden MacDonald is reading for a BS in physics at the University of British Columbia.